Could an acquiring corporate group switch from separate to combined Virginia returns by adopting the target group's filing method without advance permission?

Subject

The Parent and affiliated entities were required to file separate corporate income tax returns for the taxable years.

Plain-English summary

A parent corporation and its existing subsidiaries had historically filed separate Virginia returns. After acquiring groups that had used combined filing, the parent filed combined returns for 2010 through 2012 without first receiving permission to change methods.

Virginia required separate returns. The acquiring group's existing election controlled, and Department policy required the target group to adopt the acquirer's method. A filing-method change generally applied only prospectively after a timely request.

The acquisition also failed the Department's merger-of-equals test because the target group's net value was less than 45% of the combined value. Virginia upheld the subsidiary assessments, but allowed the group to change from separate to combined filing beginning with 2015 if it followed the stated return instructions.

What this means for you

• An acquisition does not automatically reopen Virginia's corporate filing-method election.
• The acquired group generally follows the acquiring group's existing method.
• Request permission before changing between separate and combined filing.
• The merger-of-equals policy requires the target to exceed the stated 45% value threshold.

Citations and references

• Va. Code § 58.1-442, including subsection C.
• 23 VAC 10-120-320 and 23 VAC 10-120-324.
• P.D. 07-155 and the filing-method Public Documents cited in the ruling.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-121

Original ruling text

June 29, 2017

Re: § 58.1-1821 Application: Corporate Income Tax

Dear *:

This will reply to your letter in which you seek correction of the corporate income tax assessments issued to the subsidiaries of * (the “Parent”) for the taxable years ended December 31, 2010 through 2012. I apologize for the delay in responding to your appeal.

FACTS

Prior to 2009, the Parent and its subsidiaries, including * (Sub A), (Sub B), and (Sub C) filed separate Virginia corporate income tax returns. In 2009, the Parent acquired (Sub D), which had historically filed a combined return with its subsidiaries. Sub D had a significant amount of property and payroll in Virginia. In 2010, the Parent acquired ** (Sub E).

The Parent filed combined Virginia corporate returns for the taxable years at issue with Sub A, Sub B, Sub D and Sub E, along with two of Sub E's subsidiaries, * (Sub F) and *** (Sub G). The Department audited the Parent and its subsidiaries and disallowed the combined filings because the Parent had not requested permission to change filing methods. As a result, assessments were issued to each of the subsidiaries included in the combined filing. The Parent appealed, contending it adopted the combined filing method for Virginia corporate income tax purposes because Sub D had a significant presence in Virginia and filed combined returns with its subsidiaries. It also asserts the combined filing was a “merger of equals.”

DETERMINATION

Filing Status Election

Virginia Code § 58.1-442 allows corporations to elect to file returns as separate, combined, or consolidated entities regardless of how the corporations file their federal income tax returns. Title 23 of the Virginia Administrative Code (VAC) 10-120-320 provides that in the first year, two or more members of an affiliated group of corporations are required to file Virginia returns, the group may elect to file separate returns, a combined return, or a consolidated return.

The Parent argues it made a valid election to file a combined return because Sub D's corporate family had significantly more Virginia presence than the Parent and its subsidiaries. The Parent, therefore, reasoned it was more appropriate to adopt the filing method of the predominant Virginia entity.

The Department has consistently held that a parent, even a new parent corporation, moving into Virginia does not constitute a new election for filing status purposes. See Public Document P.D. 92-75 (5/29/1992), P.D. 97-163 (4/10/1997), and P.D. 99-282 (10/15/1999). In addition, the Department's longstanding policy has been to require the target group to adopt the election of the acquiring group. See P.D. 93-187 (8/26/1993), P.D. 94-212 (7/05/1994) and P.D. 12-200 (12/06/2012). In this case, the Parent and its subsidiaries had elected and had been filing separate returns when it acquired Sub D and its subsidiaries.

Title 23 VAC 10-120-320 B requires all returns for taxable years subsequent to an election to be filed on the same basis unless permission to change is granted by the Department. The Department has a longstanding policy denying retroactive permission to change a corporate filing status. See P.D. 91-271 (10/23/1991) and P.D. 93-153 (7/23/1993). Under Title 23 VAC 10-120-324, changes between separate and combined filing status will generally be allowed if permission to change is requested on a timely basis because allocation and apportionment among members of the affiliated group are unaffected by either filing method. Permission to change will generally be effective only for returns filed on or after the date the permission to change was filed.

Virginia Code § 58.1-442 C allows a group of affiliated corporations that has filed Virginia income tax returns on the same basis for at least the preceding 20 years to be granted permission to change the basis of the type of return filed from consolidated to separate or from separate or combined to consolidated. In this case, the requested change of filing status is from separate to combined, not from consolidated to separate or from separate or combined to consolidated. Moreover, none of the subsidiaries have filed with the Parent for 20 years.

Merger of Equals

The Parent has also asked the Department to treat its acquisition of Sub D as a merger of equals. In P.D. 07-155 (10/4/2007), the Department ruled that when a merger or acquisition occurs between two affiliated groups of corporations (1) neither of which owned any substantial interest in the other prior to the merger, and (2) where the total assets or net value of the target group is almost equal to or greater than that of the acquiring group on the date of the transaction, the resulting new affiliated group may choose to file Virginia income tax returns using the filing method previously elected by the acquiring group or the target group.

Further, for purposes of the test in number 2 above, the affiliated groups involved in the merger or acquisition would be considered to be almost equal if the target group's assets or net value immediately prior to the merger or acquisition transaction is greater than 45% of the combined value of the acquiring group and target group. The documents provided indicate that Sub D's net value was less than 45% of value of the Parent. Accordingly, the transaction between the Parent and Sub D did not meet the Department's policy requirements of a merger of equals.

CONCLUSION

Based on this determination, the Parent and affiliated entities were required to file separate corporate income tax returns for the 2010 through 2012 taxable years. Accordingly, the assessments issued against Sub A, Sub D, Sub E, Sub F, and Sub G are upheld.

Despite the results of this determination, it is apparent that the affiliated group desires to change its filing status from separate to combined. Although the Parent has not requested to do so, the Department will allow a change to the combined filing method beginning with the taxable year ended December 31, 2015, in lieu of separate filing if so desired. The Parent should attach a copy of this letter to its amended 2015 return, if required, and its 2016 combined return as its indication to accept the filing status change to the combined filing status. If combined returns were filed for the 2013 and 2014 taxable years, the Parent should file amended returns and the affiliates file returns in accordance with this determination.

The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/601.B